Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
________________________________________________________________
FORM 10-Q
________________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                      TO                     
COMMISSION FILE NUMBER: 0-23599
________________________________________________________________
MERCURY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
________________________________________________________________
 
MASSACHUSETTS
 
04-2741391
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 RIVERNECK ROAD
CHELMSFORD, MA
 
01824
(Address of principal executive offices)
 
(Zip Code)
978-256-1300
(Registrant’s telephone number, including area code)
 ________________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Shares of Common Stock outstanding as of January 31, 2017: 41,043,509 shares




MERCURY SYSTEMS, INC.
INDEX
 
 
 
PAGE
NUMBER
PART I. FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
 


2



PART I. FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
MERCURY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited)
 
December 31,
2016
 
June 30,
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
46,185

 
$
81,691

Accounts receivable, net of allowance for doubtful accounts of $52 and $92 at December 31, 2016 and June 30, 2016, respectively
68,827

 
73,427

Unbilled receivables and costs in excess of billings
28,052

 
22,467

Inventory
70,088

 
58,284

Prepaid income taxes
5,049

 
3,401

Prepaid expenses and other current assets
6,646

 
6,122

Total current assets
224,847

 
245,392

Restricted cash

 
264

Property and equipment, net
39,379

 
28,337

Goodwill
366,791

 
344,027

Intangible assets, net
122,308

 
116,673

Other non-current assets
1,952

 
1,803

Total assets
$
755,277

 
$
736,496

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
26,236

 
$
26,723

Accrued expenses
10,547

 
10,273

Accrued compensation
15,841

 
13,283

Deferred revenues and customer advances
5,896

 
7,365

Current portion of long-term debt
10,000

 
10,000

Total current liabilities
68,520

 
67,644

Deferred income taxes
11,954

 
11,842

Income taxes payable
700

 
700

Long-term debt
180,710

 
182,275

Other non-current liabilities
8,677

 
991

Total liabilities
270,561

 
263,452

Commitments and contingencies (Note M)


 


Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.01 par value; 85,000,000 shares authorized; 39,240,893 and 38,675,340 shares issued and outstanding at December 31, 2016 and June 30, 2016, respectively
392

 
387

Additional paid-in capital
360,477

 
357,500

Retained earnings
123,233

 
114,210

Accumulated other comprehensive income
614

 
947

Total shareholders’ equity
484,716

 
473,044

Total liabilities and shareholders’ equity
$
755,277

 
$
736,496


The accompanying notes are an integral part of the consolidated financial statements.

3



MERCURY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except per share data)
(Unaudited)
 
 
 
Three Months Ended 
 December 31,
 
Six Months Ended 
 December 31,
 
 
2016
 
2015
 
2016
 
2015
Net revenues
 
$
98,014

 
$
60,417

 
$
185,663

 
$
118,826

Cost of revenues
 
50,625

 
30,678

 
98,830

 
60,785

Gross margin
 
47,389

 
29,739

 
86,833

 
58,041

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
19,320

 
12,583

 
36,864

 
24,709

Research and development
 
13,156

 
8,845

 
25,994

 
17,711

Amortization of intangible assets
 
4,888

 
1,638

 
9,490

 
3,351

Restructuring and other charges
 
69

 
221

 
366

 
559

Impairment of long-lived assets
 

 
231

 

 
231

Acquisition costs and other related expenses
 
998

 
(148
)
 
1,419

 
1,980

Total operating expenses
 
38,431

 
23,370

 
74,133

 
48,541

Income from operations
 
8,958

 
6,369

 
12,700

 
9,500

Interest income
 
10

 
26

 
50

 
50

Interest expense
 
(1,898
)
 
(5
)
 
(3,720
)
 
(7
)
Other (expense) income, net
 
(87
)
 
83

 
513

 
154

Income before income taxes
 
6,983

 
6,473

 
9,543

 
9,697

Tax provision
 
1,779

 
1,433

 
520

 
1,801

Net income
 
$
5,204

 
$
5,040

 
$
9,023

 
$
7,896

Basic net earnings per share
 
$
0.13

 
$
0.15

 
$
0.23

 
$
0.24

Diluted net earnings per share
 
$
0.13

 
$
0.15

 
$
0.23

 
$
0.23

 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
39,151

 
33,120

 
39,004

 
33,047

Diluted
 
39,985

 
33,831

 
39,920

 
33,819

 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
$
5,204

 
$
5,040

 
$
9,023

 
$
7,896

Foreign currency translation adjustments
 
(341
)
 
(28
)
 
(333
)
 
(11
)
Total comprehensive income
 
$
4,863

 
$
5,012

 
$
8,690

 
$
7,885

The accompanying notes are an integral part of the consolidated financial statements.


4



MERCURY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended 
 December 31,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
9,023

 
$
7,896

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
15,176

 
6,559

Stock-based compensation expense
7,725

 
5,094

Benefit for deferred income taxes
(1,002
)
 
(894
)
Impairment of goodwill and long-lived assets

 
231

Non-cash interest expense
935

 

Other non-cash items
(341
)
 
(384
)
Changes in operating assets and liabilities, net of effects of businesses acquired:
 
 
 
Accounts receivable, unbilled receivables, and costs in excess of billings
1,189

 
(6,254
)
Inventory
(3,882
)
 
(4,677
)
Prepaid income taxes
(1,623
)
 
867

Prepaid expenses and other current assets
376

 
3,315

Other non-current assets
(97
)
 
(860
)
Accounts payable and accrued expenses
(1,903
)
 
5,902

Deferred revenues and customer advances
(1,310
)
 
2,034

Income taxes payable
305

 
47

Other non-current liabilities
(50
)
 
(39
)
Net cash provided by operating activities
24,521

 
18,837

Cash flows from investing activities:
 
 
 
Acquisition of business, net of cash acquired
(38,764
)
 
(9,764
)
Purchases of property and equipment
(13,753
)
 
(3,156
)
Increase in other investing activities
(111
)
 
(185
)
Net cash used in investing activities
(52,628
)
 
(13,105
)
Cash flows from financing activities:
 
 
 
Proceeds from employee stock plans
2,733

 
2,297

Payments for retirement of common stock
(7,560
)
 
(4,124
)
Payments of term debt
(2,500
)
 

Net cash used in financing activities
(7,327
)
 
(1,827
)
Effect of exchange rate changes on cash and cash equivalents
(72
)
 
63

Net (decrease) increase in cash and cash equivalents
(35,506
)
 
3,968

Cash and cash equivalents at beginning of period
81,691

 
77,586

Cash and cash equivalents at end of period
$
46,185

 
$
81,554

Cash paid during the period for:
 
 
 
Interest
$
2,785

 
$
7

Income taxes
$
2,731

 
$
1,759

Supplemental disclosures—non-cash activities:
 
 
 
Non-cash investing activity
$
1,816

 
$

The accompanying notes are an integral part of the consolidated financial statements.

5



MERCURY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share data)
(Unaudited)
A.
Description of Business
Mercury Systems, Inc. (the “Company” or “Mercury”) is a leading commercial provider of secure sensor and mission processing subsystems. Optimized for customer and mission success, its solutions power a wide variety of critical defense and intelligence programs. The Company is pioneering a next-generation defense electronics business model specifically designed to meet the industry's current and emerging technology and business needs. The Company delivers affordable innovative solutions, rapid time-to-value and service and support to its defense prime contractor customers. The Company's products and solutions have been deployed in more than 300 programs with over 25 different defense prime contractors. Key programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program ("SEWIP"), Gorgon Stare, F-35, Predator, Reaper and Paveway. The Company's organizational structure allows it to deliver capabilities that combine technology building blocks and deep domain expertise in the aerospace and defense sector.
B.
Summary of Significant Accounting Policies
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to the Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures, normally included in annual consolidated financial statements have been condensed or omitted pursuant to those rules and regulations; however, in the opinion of management the financial information reflects all adjustments, consisting of adjustments of a normal recurring nature, necessary for fair presentation. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the fiscal year ended June 30, 2016 which are contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on August 16, 2016. The results for the three and six months ended December 31, 2016 are not necessarily indicative of the results to be expected for the full fiscal year.
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
RECLASSIFICATION
The Company has restated the income tax provision for the three and six months ended December 31, 2015 by $247 and $1,143, respectively, for the adoption of FASB Accounting Standards Update (“ASU”) 2016-09, Improvements to Employee Share-Based Payment Accounting. The adoption resulted in a decrease in the income tax provision in both periods associated with excess tax benefits, which previously was reflected as a change in additional paid in capital before the adoption of this ASU. The Company’s Consolidated Statements of Operations and Comprehensive Income and Consolidated Statements of Cash Flows have been updated to reflect this change.
The Company included costs related to the sustainment of its product portfolio as research and development expense, which was previously included as costs of revenues on the Consolidated Statements of Operations and Comprehensive Income. For comparative purposes, for the three and six months ended December 31, 2015, the Company has reclassified $1,161 and $1,934, respectively, from costs of revenues to research and development expense.
BUSINESS COMBINATIONS
The Company utilizes the acquisition method of accounting under FASB ASC 805, Business Combinations, (“FASB ASC 805”), for all transactions and events which it obtains control over one or more other businesses, to recognize the fair value of all assets and liabilities acquired, even if less than one hundred percent ownership is acquired, and in establishing the acquisition date fair value as the measurement date for all assets and liabilities assumed. The Company also utilizes FASB ASC 805 for the initial

6



recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in business combinations.
FOREIGN CURRENCY
Local currencies are the functional currency for the Company’s subsidiaries in Switzerland, the United Kingdom, and Japan. The accounts of foreign subsidiaries are translated using exchange rates in effect at period-end for assets and liabilities and at average exchange rates during the period for results of operations. Deferred taxes are not recognized for translation-related temporary differences of foreign subsidiaries as their undistributed earnings are considered to be permanently reinvested. The related translation adjustments are reported in accumulated other comprehensive income in shareholders’ equity. Gains (losses) resulting from foreign currency transactions are included in other income (expense) in the Consolidated Statements of Operations and Comprehensive Income and were immaterial for all periods presented.
REVENUE RECOGNITION
The Company relies upon FASB ASC 605, Revenue Recognition, to account for its revenue transactions. Revenue is recognized upon shipment provided that title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured, and customer acceptance criteria, if any, have been successfully demonstrated. Out-of-pocket expenses that are reimbursable by the customer are included in revenue and cost of revenue.
Certain contracts with customers require the Company to perform tests of its products prior to shipment to ensure their performance complies with the Company’s published product specifications and, on occasion, with additional customer-requested specifications. In these cases, the Company conducts such tests and, if they are completed successfully, includes a written confirmation with each order shipped. As a result, at the time of each product shipment, the Company believes that no further customer testing requirements exist and that there is no uncertainty of acceptance by its customer.
The Company uses FASB ASU No. 2009-13 (“FASB ASU 2009-13”), Multiple-Deliverable Revenue Arrangements. FASB ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence (“VSOE”) if available; (2) third-party evidence (“TPE”) if VSOE is not available; and (3) best estimated selling price (“BESP”), if neither VSOE nor TPE is available. Additionally, FASB ASU 2009-13 expands the disclosure requirements related to a vendor’s multiple-deliverable revenue arrangements. 
The Company enters into multiple-deliverable arrangements that may include a combination of hardware components, related integration or other services. These arrangements generally do not include any performance-, cancellation-, termination- or refund-type provisions. Total revenue recognized under multiple-deliverable revenue arrangements was 23% and 29% of total revenues in the three and six months ended December 31, 2016, respectively. Total revenue recognized under multiple-deliverable revenue arrangements was 36% and 42% of total revenues in the three and six months ended December 31, 2015, respectively.
In accordance with the provisions of FASB ASU 2009-13, the Company allocates arrangement consideration to each deliverable in an arrangement based on its relative selling price. The Company generally expects that it will not be able to establish VSOE or TPE due to limited single element transactions and the nature of the markets in which the Company competes, and, as such, the Company typically determines its relative selling price using BESP. The objective of BESP is to determine the price at which the Company would transact if the product or service were sold by the Company on a standalone basis.
The Company's determination of BESP involves the consideration of several factors based on the specific facts and circumstances of each arrangement. Specifically, the Company considers the cost to produce the deliverable, the anticipated margin on that deliverable, the selling price and profit margin for similar parts, the Company’s ongoing pricing strategy and policies (as evident from the price list established and updated by management on a regular basis), the value of any enhancements that have been built into the deliverable and the characteristics of the varying markets in which the deliverable is sold.
The Company analyzes the selling prices used in its allocation of arrangement consideration at a minimum on an annual basis. Selling prices will be analyzed on a more frequent basis if a significant change in the Company’s business necessitates a more timely analysis or if the Company experiences significant variances in its selling prices.
Each deliverable within the Company’s multiple-deliverable revenue arrangements is accounted for as a separate unit of accounting under the guidance of FASB ASU 2009-13 if both of the following criteria are met: the delivered item or items have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. The Company's revenue arrangements generally do not include a general right of return relative to delivered products. The Company considers a deliverable to have standalone value if the item is sold separately by the Company or another vendor or if the item could be resold by the customer.

7



Deliverables not meeting the criteria for being a separate unit of accounting are combined with a deliverable that does meet that criterion. The appropriate allocation of arrangement consideration and recognition of revenue is then determined for the combined unit of accounting.
The Company also engages in long-term contracts for development, production and services activities which it accounts for consistent with FASB ASC 605-35, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and other relevant revenue recognition accounting literature. The Company considers the nature of these contracts and the types of products and services provided when determining the proper accounting for a particular contract. Generally for fixed-price contracts, other than service-type contracts, revenue is recognized primarily under the percentage of completion method or, for certain short-term contracts, by the completed contract method. Revenue from service-type fixed-price contracts is recognized ratably over the contract period or by other appropriate input or output methods to measure service provided, and contract costs are expensed as incurred. The Company establishes billing terms at the time project deliverables and milestones are agreed. The risk to the Company on a fixed-price contract is that if estimates to complete the contract change from one period to the next, profit levels will vary from period to period. For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other billable direct costs. For all types of contracts, the Company recognizes anticipated contract losses as soon as they become known and estimable.
The Company also considers whether contracts should be combined or segmented in accordance with the applicable criteria under GAAP. The Company combines closely related contracts when all the applicable criteria under GAAP are met. The combination of two or more contracts requires judgment in determining whether the intent of entering into the contracts was effectively to enter into a single project, which should be combined to reflect an overall profit rate. Similarly, the Company may separate a project, which may consist of a single contract or group of contracts, with varying rates of profitability, only if the applicable criteria under GAAP are met. Judgment also is involved in determining whether a single contract or group of contracts may be segmented based on how the arrangement was negotiated and the performance criteria. The decision to combine a group of contracts or segment a contract could change the amount of revenue and gross profit recorded in a given period.
The use of contract accounting requires significant judgment relative to estimating total contract revenues and costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, anticipated increases in wages and prices for subcontractor services and materials, and the availability of subcontractor services and materials. The Company’s estimates are based upon the professional knowledge and experience of its engineers, program managers and other personnel, who review each long-term contract monthly to assess the contract’s schedule, performance, technical matters and estimated cost at completion. Changes in estimates are applied retrospectively and when adjustments in estimated contract costs are identified, such revisions may result in current period adjustments to earnings applicable to performance in prior periods.
Contract costs also may include estimated contract recoveries for matters such as contract changes and claims for unanticipated contract costs. The Company records revenue associated with these matters only when the amount of recovery can be estimated reliably and realization is probable.
The Company defines service revenues as revenue from activities that are not associated with the design, development, production, or delivery of tangible assets, software or specific capabilities sold. Examples of the Company's service revenues include: analyst services and systems engineering support, consulting, maintenance and other support, testing and installation. The Company combines its product and service revenues into a single class as service revenues are less than 10 percent of total revenues.
The Company does not provide its customers with rights of product return, other than those related to warranty provisions that permit repair or replacement of defective goods. The Company accrues for anticipated warranty costs upon product shipment. Revenues from product royalties are recognized upon invoice by the Company. Additionally, all revenues are reported net of government assessed taxes (e.g., sales taxes or value-added taxes).
WEIGHTED-AVERAGE SHARES
Weighted-average shares were calculated as follows:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2016
 
2015
 
2016
 
2015
Basic weighted-average shares outstanding
39,151

 
33,120

 
39,004

 
33,047

Effect of dilutive equity instruments
834

 
711

 
916

 
772

Diluted weighted-average shares outstanding
39,985

 
33,831

 
39,920

 
33,819

Equity instruments to purchase 9 and 6 shares of common stock were not included in the calculation of diluted net earnings per share for the three and six months ended December 31, 2016 because the equity instruments were anti-dilutive. Equity

8



instruments to purchase 2 and 25 shares of common stock were not included in the calculation of diluted net earnings per share for the three and six months ended December 31, 2015 because the equity instruments were anti-dilutive.
C. Acquisitions
CES CREATIVE ELECTRONIC SYSTEMS AQUISITION
On November 4, 2016, the Company and CES Creative Electronic Systems S.A. ("CES") entered into a Stock Purchase Agreement, pursuant to which, Mercury acquired CES for a total purchase price of $39,123, subject to net working capital and net debt adjustments. The acquisition and associated transaction expenses were funded with cash on hand. Based in Geneva, Switzerland, CES is a leading provider of embedded solutions for military and aerospace mission-critical computing applications. CES specializes in the design, development and manufacture of safety-certifiable product and subsystems solutions including: primary flight control units, flight test computers, mission computers, command and control processors, graphics and video processing and avionics-certified Ethernet and IO. CES has decades of experience designing subsystems deployed in applications certified up to the highest levels of design assurance. CES products and solutions are used on platforms such as aerial refueling tankers and multi-mission aircraft, as well as the several types of unmanned platforms.
The following table presents the net purchase price and the preliminary fair values of the assets and liabilities of CES:
 
Amounts 
Consideration transferred
 

Cash paid at closing
$
39,123

Working capital adjustment
(359
)
Net purchase price
$
38,764

 
 

Estimated fair value of tangible assets acquired and liabilities assumed
 

Accounts receivable and cost in excess of billings
$
2,698

Inventory
8,072

Fixed assets
1,468

Current and non-current deferred tax assets
312

Other current and non-current assets
1,073

Current liabilities
(3,141
)
Non-current liabilities
(8,031
)
Non-current deferred tax liabilities
(1,169
)
Estimated fair value of net tangible assets acquired
1,282

Estimated fair value of identifiable intangible assets
15,134

Estimated goodwill
22,348

Estimated fair value of assets acquired
38,764

Net purchase price
$
38,764

The amounts above represent the preliminary fair value estimates as of December 31, 2016 and are subject to subsequent adjustment as the Company obtains additional information during the measurement period. The preliminary identifiable intangible asset estimates include customer relationships of $9,472 with a useful life of 9 years and developed technology of $5,662 with a useful life of 7 years. Any subsequent adjustments to these fair value estimates occurring during the measurement period will result in an adjustment to goodwill.
The goodwill of $22,348 largely reflects the potential synergies and expansion of the Company's offerings across product lines and markets complementary to the Company's existing products and markets. CES provides the Company with in mission computing, safety-critical avionics and platform management that are in demand from our customers. These new capabilities will also substantially expand Mercury’s addressable market into commercial aerospace, defense platform management, C4I and mission computing markets that are aligned to Mercury’s existing market focus. The acquisition is directly aligned with the Company's strategy of expanding its capabilities, services and offerings along the sensor processing chain. The goodwill from this acquisition is reported under the MCE reporting unit.
The revenues and net income from CES included in the Company's consolidated results for the three and six months ended December 31, 2016 were $3,956 and $207, respectively.

9



CARVE-OUT BUSINESS AQUISITION
On March 23, 2016, the Company and Microsemi Corporation (“Microsemi”) entered into a Stock Purchase Agreement, pursuant to which, Microsemi agreed to sell all the membership interests in its custom microelectronics, RF and microwave solutions and embedded security operations (the “Carve-Out Business”) to the Company for $300,000 in cash on a cash-free, debt-free basis, subject to a working capital adjustment. On May 2, 2016, the transaction closed and the Company acquired the Carve-Out Business. Pursuant to the terms of the Stock Purchase Agreement, all outstanding Carve-Out Business employee stock awards that were unvested at the closing were replaced by Mercury. The replacement stock awards granted were determined based on a conversion ratio provided in the Stock Purchase Agreement. Mercury funded the acquisition with a combination of a new $200,000 bank term loan facility (see Note I) and cash on hand, which included net proceeds of approximately $92,788 raised from an underwritten common stock public offering.
The following table presents the net purchase price and the preliminary fair values of the assets and liabilities of the Carve-Out Business:
 
Amounts 
Consideration transferred
 

Cash paid at closing
$
300,000

Value allocated to replacement awards
407

Net purchase price
$
300,407

 
 

Estimated fair value of tangible assets acquired and liabilities assumed
 

Accounts receivable and cost in excess of billings
$
17,092

Inventory
25,477

Fixed assets
13,996

Other current and non-current assets
524

Current liabilities
(4,692
)
Non-current deferred tax liabilities
(25,449
)
Estimated fair value of net tangible assets acquired
26,948

Estimated fair value of identifiable intangible assets
102,800

Estimated goodwill
170,659

Estimated fair value of assets acquired
300,407

Net purchase price
$
300,407

The amounts above represent the preliminary fair value estimates as of December 31, 2016 and are subject to subsequent adjustment as the Company obtains additional information during the measurement period and finalizes its fair value estimates. The preliminary identifiable intangible asset estimates include customer relationships of $70,900, completed technology of $29,700 and backlog of $2,200. Any subsequent adjustments to these fair value estimates occurring during the measurement period will result in an adjustment to goodwill.
The goodwill of $170,659 largely reflects the potential synergies and expansion of the Company's offerings across product lines and markets complementary to the Company's existing products and markets. The Carve-Out Business provides the Company with additional capability and expertise related to embedded security custom microelectronics, and microwave and radio frequency technology. The acquisition is directly aligned with the Company's strategy of expanding its capabilities, services and offerings along the sensor processing chain. The goodwill from this acquisition is reported under the Carve-Out Business reporting unit. As of December 31, 2016, the Company had $29,461 of goodwill related to the Carve-Out Business deductible for tax purposes.
The revenues and net loss from the Carve-Out Business included in the Company's consolidated results for the three months ended December 31, 2016 were $25,986 and $(1,495), respectively. The revenues and net loss from the Carve-Out Business included in the Company's consolidated results for the six months ended December 31, 2016 were $50,296 and $(3,913), respectively.

10



Pro Forma Financial Information
The following tables summarize the supplemental statements of operations information on an unaudited pro forma basis as if the Carve-Out Business acquisition had occurred on July 1, 2015:
 
Three Months ended December 31,
 
Six Months ended December 31,
 
2015
 
2015
Pro forma net revenues
$
85,393

 
$
168,496

Pro forma net income
$
5,041

 
$
7,080

Basic pro forma net earnings per share
$
0.13

 
$
0.18

Diluted pro forma net earnings per share
$
0.13

 
$
0.18

The unaudited pro forma results presented above are for illustrative purposes only for the applicable periods and do not purport to be indicative of the actual results which would have occurred had the transaction been completed as of the beginning of the period, nor are they indicative of results of operations which may occur in the future.
LEWIS INNOVATIVE TECHNOLOGIES ACQUISITION
On December 16, 2015, the Company entered into a share purchase agreement (the “Share Purchase Agreement”) with Lewis Innovative Technologies, Inc. (“LIT”) and the holders of the equity interests of LIT. Pursuant to the Share Purchase Agreement, the Company completed its purchase of all of the equity interests in LIT, and LIT became a wholly-owned subsidiary of the Company. Based in Huntsville, Alabama, LIT provides advanced security technology and development services necessary for protecting systems critical to national security while meeting strict Department of Defense (“DoD”) program protection requirements.
The Company acquired LIT for a cash purchase price of $9,756. The Company funded the purchase with cash on hand. The purchase price was subject to a post-closing adjustment based on a determination of LIT's closing net working capital. In accordance with the Share Purchase Agreement, $1,000 of the purchase price was placed into escrow to support the post-closing working capital adjustment and the sellers' indemnification obligations. The escrow is available for indemnification claims through June 16, 2017. The Company acquired LIT free of debt.
The fair value estimates of LIT's assets and liabilities have not changed since June 30, 2016. On December 15, 2016, the measurement period for LIT expired with no further adjustments required.
D.
Fair Value of Financial Instruments
The following table summarizes the Company’s financial assets measured at fair value on a recurring basis at December 31, 2016: 
 
 
Fair Value Measurements
 
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
115

 
$

 
$
115

 
$

Total
 
$
115

 
$

 
$
115

 
$

The carrying values of cash and cash equivalents, including money market funds, restricted cash, accounts receivable and payable, and accrued liabilities approximate fair value due to the short-term maturities of these assets and liabilities. The fair value of the Company’s certificates of deposit are determined through quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable. The Company determined the face value of its long-term debt approximates fair value at December 31, 2016 due to the recent issuance and stability of interest rates during this period. The Company has an immaterial cost-method investment. The cost-method investment, which is presented within other non-current assets in the accompanying consolidated balance sheets, does not have a readily determinable fair value, as such the Company recorded the investment at cost and will continue to evaluate the asset for impairment on a quarterly basis.

11



E.
Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market value, and consists of materials, labor and overhead. On a quarterly basis, the Company uses consistent methodologies to evaluate inventory for net realizable value. Once an item is written down, the value becomes the new inventory cost basis. The Company reduces the value of inventory for excess and obsolete inventory, consisting of on-hand inventory in excess of estimated usage. The excess and obsolete inventory evaluation is based upon assumptions about future demand, history, product mix and possible alternative uses. Inventory was comprised of the following:
 
 
December 31, 2016
 
June 30, 2016
Raw materials
 
$
35,776

 
$
31,205

Work in process
 
19,536

 
15,967

Finished goods
 
14,776

 
11,112

Total
 
$
70,088

 
$
58,284

The $11,804 increase in inventory was primarily due to the inclusion of inventory from CES. There are no amounts in inventory relating to contracts having production cycles longer than one year.
F.
Goodwill
The following table sets forth the changes in the carrying amount of goodwill by reporting unit for the six months ended December 31, 2016:
 
 
MCE
 
MDS
 
Carve-Out Business
 
Total
Balance at June 30, 2016
 
$
134,378

 
$
39,406

 
$
170,243

 
$
344,027

Goodwill adjustment for the Carve-Out Business acquisition
 

 

 
416

 
416

Goodwill arising from the CES acquisition
 
22,348

 

 

 
22,348

Balance at December 31, 2016
 
$
156,726

 
$
39,406

 
$
170,659

 
$
366,791

During the six months ended December 31, 2016, the Company recorded a $416 adjustment to goodwill related to the acquisition of the Carve-Out Business. The adjustment was the result of changes in fair value estimates derived from additional information obtained during the measurement period.
In the six months ended December 31, 2016, there were no triggering events, as defined by FASB ASC 350, Intangibles - Goodwill and Other, which required an interim goodwill impairment test. The Company performs its annual goodwill impairment test in the fourth quarter of each fiscal year.
G.
Restructuring
The following table presents the detail of activity for the Company’s restructuring plans:
 
 
Severance &
Related
 
Facilities
& Other
 
Total
Restructuring liability at June 30, 2016
 
$
190

 
$
736

 
$
926

Restructuring and other charges
 
214

 
152

 
366

Cash paid
 
(242
)
 
(529
)
 
(771
)
Restructuring liability at December 31, 2016
 
$
162

 
$
359

 
$
521

During the six months ended December 31, 2016, the Company incurred net restructuring and other charges of $366. Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities.
All of the restructuring and other charges are classified as operating expenses in the Consolidated Statements of Operations and Comprehensive Income and any remaining severance obligations are expected to be paid within the next twelve months. The restructuring liability is classified as accrued expenses in the Consolidated Balance Sheets.

12



H.
Income Taxes
The Company recorded an income tax provision of $1,779 and of $1,433 on income from operations before income taxes of $6,983 and $6,473 for the three months ended December 31, 2016 and 2015, respectively. The Company recorded an income tax provision of $520 and of $1,801 on income from operations before income taxes of $9,543 and $9,697 for the six months ended December 31, 2016 and 2015, respectively. The effective tax rate for the three and six months ended December 31, 2016 and 2015 differed from the federal statutory rate primarily due to federal research and development credits, domestic manufacturing deduction, excess tax benefits related to stock compensation, and state taxes.
No material changes in the Company’s unrecognized tax positions occurred during the six months ended December 31, 2016. The Company is currently under audit by the Internal Revenue Service for fiscal year 2013. There have been no significant changes to the status of this examination during the six months ended December 31, 2016. It is reasonably possible that within the next 12 months the Company’s unrecognized tax benefits, exclusive of interest, may decrease by up to $757 at the conclusion of the audit. The Company expects that the decrease, if recognized, would not affect the effective tax rate.
I.
Debt
TERM LOAN AND REVOLVING CREDIT FACILITIES
On May 2, 2016, the Company and certain of its subsidiaries, as guarantors, entered into a Credit Agreement (the “Credit Agreement”) with a syndicate of commercial banks and Bank of America, N.A acting as the administrative agent. The Credit Agreement provides for a $200,000 term loan facility ("Term Loan") and a $100,000 revolving credit facility ("Revolver"). As of December 31, 2016, the Company’s outstanding balance on the Term Loan was $197,500, before $6,790 of unamortized debt issuance costs. The stated interest rate of the Term Loan was 3.0% as of December 31, 2016.
The Company was in compliance with all covenants and conditions under the Credit Agreement. There were no borrowings against the Revolver; however, there were outstanding letters of credit of $5,624 as of December 31, 2016.
J.
Stock-Based Compensation
STOCK OPTION PLANS
The number of shares authorized for issuance under the Company’s 2005 Stock Incentive Plan, as amended and restated (the “2005 Plan”), is 15,252 shares at December 31, 2016. The 2005 Plan provides for the grant of non-qualified and incentive stock options, restricted stock, stock appreciation rights and deferred stock awards to employees and non-employees. All stock options are granted with an exercise price of not less than 100% of the fair value of the Company’s common stock at the date of grant and the options generally have a term of seven years. There were 2,809 shares available for future grant under the 2005 Plan at December 31, 2016.
As part of the Company's ongoing annual equity grant program for employees, the Company grants performance-based restricted stock awards to certain executives pursuant to the 2005 Plan. Performance awards vest based on the requisite service period subject to the achievement of specific financial performance targets. Based on the performance targets, some of these awards require graded vesting which results in more rapid expense recognition compared to traditional time-based vesting over the same vesting period. The Company monitors the probability of achieving the performance targets on a quarterly basis and may adjust periodic stock compensation expense accordingly.
EMPLOYEE STOCK PURCHASE PLAN
The number of shares authorized for issuance under the Company’s 1997 Employee Stock Purchase Plan, as amended and restated (“ESPP”), is 1,800 shares. Under the ESPP, rights are granted to purchase shares of common stock at 85% of the lesser of the market value of such shares at either the beginning or the end of each six-month offering period. The ESPP permits employees to purchase common stock through payroll deductions, which may not exceed 10% of an employee’s compensation as defined in the ESPP. There were 50 and 46 shares issued under the ESPP during the six months ended December 31, 2016 and 2015, respectively. Shares available for future purchase under the ESPP totaled 348 at December 31, 2016.

13



STOCK OPTION AND AWARD ACTIVITY
The following table summarizes activity of the Company’s stock option plans since June 30, 2016:
 
 
Options Outstanding
 
 
Number of
Shares
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining
Contractual Term
(Years)
Outstanding at June 30, 2016
 
258

 
$
13.34

 
1.06
Granted
 

 

 
 
Exercised
 
(126
)
 
13.27

 
 
Cancelled
 

 

 
 
Outstanding at December 31, 2016
 
132

 
$
13.41

 
0.82
The following table summarizes the status of the Company’s non-vested restricted stock awards since June 30, 2016:
 
 
Non-vested Restricted Stock Awards
 
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Outstanding at June 30, 2016
 
1,666

 
$
13.09

Granted
 
675

 
23.92

Vested
 
(702
)
 
11.41

Forfeited
 
(28
)
 
15.99

Outstanding at December 31, 2016
 
1,611

 
$
18.31

STOCK-BASED COMPENSATION EXPENSE
The Company recognized the full expense of its share-based payment plans in the consolidated statements of operations for the six months ended December 31, 2016 and 2015 in accordance with FASB ASC 718, Compensation - Stock Compensation. The Company had $177 and $153 of capitalized stock-based compensation expense on the Consolidated Balance Sheets as of December 31, 2016 and 2015, respectively. Under the fair value recognition provisions of FASB ASC 718, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the service period, net of estimated forfeitures. The following table presents share-based compensation expenses included in the Company’s consolidated statements of operations:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2016
 
2015
 
2016
 
2015
Cost of revenues
$
148

 
$
6

 
$
223

 
$
155

Selling, general and administrative
3,539

 
2,063

 
6,578

 
4,191

Research and development
406

 
323

 
924

 
748

Share-based compensation expense before tax
4,093

 
2,392

 
7,725

 
5,094

Income taxes
(1,575
)
 
(992
)
 
(2,964
)
 
(2,033
)
Share-based compensation expense, net of income taxes
$
2,518

 
$
1,400

 
$
4,761

 
$
3,061

K.
Pension
DEFINED BENEFIT PLAN
With the acquisition of CES on November 4, 2016, the Company assumed a pension plan (the "Plan") for Swiss employees, mandated by Swiss law. The Plan meets the criteria for a defined benefit plan under U.S. GAAP. The Company recognizes a net asset or liability for this defined benefit pension plan equal to the difference between the projected benefit obligation of the Plan and the fair value of the Plan’s assets. The funded status may vary from year to year due to changes in the fair value of the Plan’s assets and variations on the underlying assumptions of the Plan.

14



At the acquisition date, the Company recorded a liability of approximately $7,658 in other non-current liabilities representing the net funded status of the Plan. As described in Note C of the consolidated financial statements, the fair values of the assets acquired and liabilities assumed from CES are preliminary estimates, including the estimate of the net liability associated with the Plan. This estimate is subject to subsequent adjustment as the Company obtains additional information during the measurement period and any subsequent adjustments to this fair value estimate occurring during the measurement period will result in an adjustment to goodwill. The Company recognized net periodic benefit cost of $69 associated with the Plan from the acquisition date of November 4, 2016 through December 31, 2016. Fiscal 2017 cash contributions to the Plan are expected to be $325.
L.
Operating Segment, Geographic Information and Significant Customers
Operating segments are defined as components of an enterprise evaluated regularly by the Company's chief operating decision maker (“CODM”) in deciding how to allocate resources and assess performance. The Company is comprised of one operating and reportable segment. The Company utilized the management approach for determining its operating segment in accordance with FASB ASC 280, Segment Reporting.
The geographic distribution of the Company’s revenues is summarized as follows:
 
 
US
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
THREE MONTHS ENDED DECEMBER 31, 2016
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
91,407

 
$
5,809

 
$
798

 
$

 
$
98,014

Inter-geographic revenues
 
1,893

 

 

 
(1,893
)
 

Net revenues
 
$
93,300

 
$
5,809

 
$
798

 
$
(1,893
)
 
$
98,014

THREE MONTHS ENDED DECEMBER 31, 2015
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
58,211

 
$
653

 
$
1,553

 
$

 
$
60,417

Inter-geographic revenues
 
1,949

 
371

 

 
(2,320
)
 

Net revenues
 
$
60,160

 
$
1,024

 
$
1,553

 
$
(2,320
)
 
$
60,417

SIX MONTHS ENDED DECEMBER 31, 2016
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
174,455

 
$
6,662

 
$
4,546

 
$

 
$
185,663

Inter-geographic revenues
 
5,180

 
15

 

 
(5,195
)
 

Net revenues
 
$
179,635

 
$
6,677

 
$
4,546

 
$
(5,195
)
 
$
185,663

SIX MONTHS ENDED DECEMBER 31, 2015
 
 
 
 
 
 
 
 
 
 
Net revenues to unaffiliated customers
 
$
115,573

 
$
1,111

 
$
2,142

 
$

 
$
118,826

Inter-geographic revenues
 
3,203

 
402

 

 
(3,605
)
 

Net revenues
 
$
118,776

 
$
1,513

 
$
2,142

 
$
(3,605
)
 
$
118,826

Foreign revenue is based on the country in which the Company’s legal subsidiary is domiciled.
The geographic distribution of the Company’s long-lived assets is summarized as follows:
 
 
US
 
Europe
 
Asia Pacific
 
Eliminations
 
Total
December 31, 2016
 
$
37,863

 
$
1,496

 
$
20

 
$

 
$
39,379

June 30, 2016
 
$
28,187

 
$
127

 
$
23

 
$

 
$
28,337

Identifiable long-lived assets exclude goodwill and intangible assets.
Customers comprising 10% or more of the Company’s revenues for the periods shown below are as follows:
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
 
2016
 
2015
 
2016
 
2015
Raytheon Company
 
22
%
 
29
%
 
19
%
 
33
%
Lockheed Martin Corporation
 
13
%
 
26
%
 
19
%
 
21
%
Northrop Grumman Corporation
 
10
%
 
*

 
*

 
*

 
 
45
%
 
55
%
 
38
%
 
54
%

15



While the Company typically has customers from which it derives 10% or more of its revenue, the sales to each of these customers are spread across multiple programs and platforms. Programs comprising 10% or more of the Company’s revenues for the periods shown below are as follows:
 
 
Three Months Ended
December 31,
 
Six Months Ended
December 31,
 
 
2016
 
2015
 
2016
 
2015
F-35
 
11
%
 
13
%
 
*

 
*

Aegis
 
*

 
*

 
10
%
 
*

SEWIP
 
*

 
16
%
 
*

 
12
%
Patriot
 
*

 
11
%
 
*

 
14
%
 
 
11
%
 
40
%
 
10
%
 
26
%
*
Indicates that the amount is less than 10% of the Company’s revenues for the respective period.
M.
Commitments and Contingencies
LEGAL CLAIMS
The Company is subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business. Although legal proceedings are inherently unpredictable, the Company believes that it has valid defenses with respect to any matters currently pending against the Company and intends to defend itself vigorously. The outcome of these matters, individually and in the aggregate, is not expected to have a material impact on the Company’s cash flows, results of operations, or financial position.
INDEMNIFICATION OBLIGATIONS
The Company’s standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments the Company could be required to make under these indemnification provisions is, in some instances, unlimited.
PURCHASE COMMITMENTS
As of December 31, 2016, the Company has entered into non-cancelable purchase commitments for certain inventory components and services used in its normal operations. The purchase commitments covered by these agreements are for less than one year and aggregate to $41,603.
OTHER
As part of the Company's strategy for growth, the Company continues to explore acquisitions or strategic alliances. The associated acquisition costs incurred in the form of professional fees and services may be material to the future periods in which they occur, regardless of whether the acquisition is ultimately completed.
The Company may elect from time to time to purchase and subsequently retire shares of common stock in order to settle an individual employees’ tax liability associated with vesting of a restricted stock award or exercise of stock options. These transactions would be treated as a use of cash in financing activities in the Company's statement of cash flows.
N.
Subsequent Events
On January 26, 2017, the Company entered into an underwriting agreement. Pursuant to the terms and conditions of the underwriting agreement, the Company agreed to sell 6,000 shares of its common stock, par value $0.01 per share, at a price to the public of $33.00 per share. Pursuant to the underwriting agreement, the Company granted the underwriters an option to purchase up to an additional 900 shares of its common stock within 30 days after the date of the underwriting agreement to cover the overallotment.
The offering was made pursuant to a shelf registration statement previously filed with the SEC on August 15, 2014. On February 1, 2017, the Company closed the offering, including the full over-allotment allocation, selling an aggregate of 6,900 shares of common stock for total proceeds of $216,315 before expenses, but after underwriting fees of $11,385. The Company

16



intends to use the net proceeds for general corporate purposes, including but not limited to: the acquisition of other companies or businesses, the refinancing or repayment of debt, working capital, share repurchases and capital expenditures.
The Company has evaluated subsequent events from the date of the consolidated balance sheet through the date the consolidated financial statements were issued.

17



ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
From time to time, information provided, statements made by our employees or information included in our filings with the Securities and Exchange Commission may contain statements that are not historical facts but that are “forward-looking statements,” which involve risks and uncertainties. You can identify these statements by the use of the words “may,” “will,” “could,” “should,” “would,” “plans,” “expects,” “anticipates,” “continue,” “estimate,” “project,” “intend,” “likely,” “forecast,” “probable,” “potential” and similar expressions. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, continued funding of defense programs, the timing and amounts of such funding, general economic and business conditions, including unforeseen weakness in the Company's markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in, or in the U.S. Government’s interpretation of, federal export control or procurement rules and regulations, market acceptance of the Company's products, shortages in components, production delays or unanticipated expenses due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions and restructurings, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, increases in interest rates, changes to export regulations, increases in tax rates, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, unanticipated costs under fixed-price service and system integration engagements, and various other factors beyond our control. These risks and uncertainties also include such additional risk factors as set forth under Part I-Item 1A (Risk Factors) in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2016. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.
OVERVIEW
Mercury Systems, Inc. is a leading commercial provider of secure sensor and mission processing subsystems. Optimized for customer and mission success, our solutions power a wide variety of critical defense and intelligence programs. We are pioneering a next-generation defense electronics business model specifically designed to meet the industry’s current and emerging technology and business needs. We deliver affordable innovative solutions, rapid time-to-value and service and support to our defense prime contractor customers. Our products and solutions have been deployed in more than 300 programs with over 25 different defense prime contractors. Key programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program (“SEWIP”), Gorgon Stare, F-35, Predator, Reaper and Paveway. Our organizational structure allows us to deliver capabilities that combine technology building blocks and deep domain expertise in the aerospace and defense sector.
Our technologies and capabilities include secure embedded processing modules and subsystems, mission computers, safety-critical avionics, radio frequency (“RF”) components, multi-function assemblies and subsystems. We utilize leading edge, high performance computing technologies architected by leveraging open standards and open architectures to address highly data-intensive applications that include data signal, sensor and image processing; all of this while addressing the packaging challenges, often referred to as “SWaP” (size, weight, and power), that are common in military applications. We have design, development, and manufacturing capabilities in mission computing, safety-critical avionics and platform management. In addition, we design and manufacture RF, microwave and millimeter wave components and subsystems to meet the needs of the radar, electronic warfare (“EW”), signals intelligence (“SIGINT”) and other high bandwidth communications requirements and applications.
We also provide significant capabilities relating to pre-integrated EW, electronic attack (“EA”) and electronic counter measure (“ECM”) subsystems, SIGINT and electro-optical/infrared (“EO/IR”) processing technologies, and radar environment test and simulation systems. We deploy these solutions on behalf of defense prime contractors and the Department of Defense (“DoD”), leveraging commercially available technologies and solutions (or “building blocks”) from our business and other commercial suppliers. We leverage this technology to design and build integrated sensor processing subsystems, often including classified application-specific software and intellectual property (“IP”) for the C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), EW, and ECM markets. We bring significant domain expertise to customers, drawing on over 25 years of experience in EW, SIGINT, and radar environment test and simulation.
Since we are an OEM supplier to our commercial markets and conduct much of our business with our defense customers via commercial items, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need for our products. Because these customers may use our products in connection with a variety of defense programs or other projects of different sizes and durations, a customer’s orders for one

18



quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns do not necessarily correlate amongst customers and, therefore, we generally cannot identify sequential quarterly trends.
As of December 31, 2016, we had 1,063 employees. Our consolidated revenues, net income, net earnings per share, adjusted earnings per share ("adjusted EPS"), and adjusted EBITDA for the three months ended December 31, 2016 were $98.0 million, $5.2 million, $0.13, $0.30, and $23.0 million, respectively. Our consolidated revenues, net income, net earnings per share, adjusted EPS, and adjusted EBITDA for the six months ended December 31, 2016 were $185.7 million, $9.0 million, $0.23, $0.52, and $41.2 million, respectively. See the Non-GAAP Financial Measures section for a reconciliation to our most directly comparable GAAP financial measures.
RESULTS OF OPERATIONS:
Results of operations for the three and six month periods ended December 31, 2015 do not include results for CES Creative Electronic Systems S.A. (“CES”) and the acquired custom microelectronics, RF and microwave solutions, and embedded security operations from Microsemi Corporation (the “Carve-Out Business”) (since both businesses were acquired subsequent to December 31, 2015) and only include the results for Lewis Innovative Technologies, Inc. (“LIT”), acquired on December 16, 2015, for a portion of those periods. Accordingly, the periods presented below are not comparable.
Three months ended December 31, 2016 compared to the three months ended December 31, 2015
The following tables set forth, for the three months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
December 31, 2016
 
As a % of
Total Net
Revenue
 
December 31, 2015
 
As a % of
Total Net
Revenue
Net revenues
 
$
98,014

 
100.0
 %
 
$
60,417

 
100.0
 %
Cost of revenues
 
50,625

 
51.7

 
30,678

 
50.8

Gross margin
 
47,389

 
48.3

 
29,739

 
49.2

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
19,320

 
19.7

 
12,583

 
20.8

Research and development
 
13,156

 
13.4

 
8,845

 
14.6

Amortization of intangible assets
 
4,888

 
5.0

 
1,638

 
2.7

Restructuring and other charges
 
69

 
0.1

 
221

 
0.4

Impairment of long-lived assets
 

 

 
231

 
0.4

Acquisition costs and other related expenses
 
998

 
1.0

 
(148
)
 
(0.2
)
Total operating expenses
 
38,431

 
39.2

 
23,370

 
38.7

Income from operations
 
8,958

 
9.1

 
6,369

 
10.5

Interest income
 
10

 

 
26

 
0.1

Interest expense
 
(1,898
)
 
(1.9
)
 
(5
)
 

Other (expense) income, net
 
(87
)
 
(0.1
)
 
83

 
0.1

Income before income taxes
 
6,983

 
7.1

 
6,473

 
10.7

Tax provision
 
1,779

 
1.8

 
1,433

 
2.4

Net income
 
$
5,204

 
5.3
 %
 
$
5,040

 
8.3
 %
REVENUES
Total revenues increased $37.6 million, or 62%, to $98.0 million during the three months ended December 31, 2016 as compared to the same period in fiscal 2016. The increase in total revenues is primarily attributed to $26.0 million of revenue from the Carve-Out Business and $4.0 million from the newly acquired CES. The increase of $7.6 million organic revenue was due to higher revenues from the Reaper, Long Range Discrimination Radar ("LRDR"), F-35, and Filthy Buzzard programs, partially offset by lower Patriot and SEWIP program revenues. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, increased $2.3 million to $15.0 million during the three months ended December 31, 2016, compared to $12.7 million in the same period in the prior fiscal year. International revenues represented 15% and 21% of total revenues during the three months ended December 31, 2016 and 2015, respectively.

19



GROSS MARGIN
Gross margin was 48.3% for the three months ended December 31, 2016, a decrease of 90 basis points from the 49.2% gross margin achieved during the same period in fiscal 2016 with both periods benefiting from approximately $6.9 million and $6.5 million of high margin F-35 royalty revenues, respectively. The lower gross margin between years was driven by the amortization of $0.9 million in inventory step-up during the three months ended December 31, 2016 related to the acquisitions of the Carve-Out Business and CES, and changes in product mix.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased $6.7 million, or 54%, to $19.3 million during the three months ended December 31, 2016, compared to $12.6 million in the same period in fiscal 2016. The increase was primarily due to higher compensation related costs driven by added headcount resulting from the acquisition of the Carve-Out Business in the fourth quarter of fiscal 2016 and the acquisition of CES in the second quarter of fiscal 2017. Additionally, during the three months ended December 31, 2016, we incurred $0.4 million in non-cash rent expense associated with our new corporate headquarters in Andover, Massachusetts. Selling, general and administrative expenses as a percentage of revenues slightly decreased for the three months ended December 31, 2016 as compared to the same period in fiscal 2016. The decrease was due to higher revenues in the first three months of fiscal 2017, as compared to the same period in fiscal 2016.
RESEARCH AND DEVELOPMENT
Research and development expenses increased approximately $4.3 million, or 49%, to $13.2 million during the three months ended December 31, 2016, compared to $8.8 million during the same period in fiscal 2016. The increase was primarily due to increased headcount resulting from the acquisition of the Carve-Out Business and the acquisition of CES driving higher compensation related costs, higher depreciation and increased prototype expenditures.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges decreased to less than $0.1 million during the three months ended December 31, 2016, compared to $0.2 million during the same period in fiscal 2016. Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities.
IMPAIRMENT OF LONG-LIVED ASSETS
Pursuant to the completion of the LIT acquisition, we incurred $0.2 million impairment expense related to a pre-existing relationship during the second quarter of fiscal 2016.
ACQUISITION COSTS AND OTHER RELATED EXPENSES
We incurred $1.0 million of acquisition costs and other related expenses during the three months ended December 31, 2016, compared to ($0.1) million during the same period in fiscal 2016. The expense during the three months ended December 31, 2016 is primarily driven by the CES acquisition completed on November 4, 2016. We expect to incur acquisition costs and other related expenses periodically in the future as we continue to seek acquisition opportunities to expand our capabilities within the sensor processing chain.
INTEREST EXPENSE
We incurred $1.9 million of interest expense during the three months ended December 31, 2016 compared to less than $0.1 million in the same period in fiscal 2016. The increase was driven by $1.4 million cash interest expense related to our Term Loan and $0.5 million of non-cash interest expense related to the amortization of debt issuance costs on our Term Loan, which was entered into during the fourth quarter of fiscal 2016.
OTHER (EXPENSE) INCOME, NET
Other (expense) income, net decreased $0.2 million to ($0.1) million during the three months ended December 31, 2016, as compared to $0.1 million in the same period in fiscal 2016. Both periods include $0.3 million related to the amortization of the gain on the sale leaseback of our corporate headquarters, partially offset by $0.1 million and $0.2 million in bank fees during the three months ended December 31, 2016 and 2015, respectively. In addition, there was $0.2 million in foreign exchange losses during the three months ended December 31, 2016.
INCOME TAXES
We recorded an income tax provision of $1.8 million during the three months ended December 31, 2016 as compared to a $1.4 million income tax provision for the same period in fiscal 2016. During the three months ended December 31, 2016, and 2015, we recognized a discrete tax benefit of $0.6 million and $0.2 million, respectively, related to excess tax benefits on stock-

20



based compensation. Our effective tax rate for the three months ended December 31, 2016 and 2015 differed from the federal statutory tax rate of 35% primarily due to federal research and development credits, domestic manufacturing deduction, excess tax benefits related to stock compensation, and state taxes.
Six months ended December 31, 2016 compared to the six months ended December 31, 2015
The following tables set forth, for the six months periods indicated, financial data from the consolidated statements of operations:
(In thousands)
 
December 31, 2016
 
As a % of
Total Net
Revenue
 
December 31, 2015
 
As a % of
Total Net
Revenue
Net revenues
 
$
185,663

 
100.0
 %
 
$
118,826

 
100.0
 %
Cost of revenues
 
98,830

 
53.2

 
60,785

 
51.2

Gross margin
 
86,833

 
46.8

 
58,041

 
48.8

Operating expenses:
 
 
 
 
 
 
 
 
Selling, general and administrative
 
36,864

 
19.9

 
24,709

 
20.8

Research and development
 
25,994

 
14.0

 
17,711

 
14.9

Amortization of intangible assets
 
9,490

 
5.1

 
3,351

 
2.8

Restructuring and other charges
 
366

 
0.2

 
559

 
0.5

Impairment of long-lived assets
 

 

 
231

 
0.2

Acquisition costs and other related expenses
 
1,419

 
0.7

 
1,980

 
1.6

Total operating expenses
 
74,133

 
39.9

 
48,541

 
40.8

Income from operations
 
12,700

 
6.9

 
9,500

 
8.0

Interest income
 
50

 

 
50

 

Interest expense
 
(3,720
)
 
(2.0
)
 
(7
)
 

Other income, net
 
513

 
0.3

 
154

 
0.1

Income before income taxes
 
9,543

 
5.2

 
9,697

 
8.1

Tax provision
 
520

 
0.3

 
1,801

 
1.5

Net income
 
$
9,023

 
4.9
 %
 
$
7,896

 
6.6
 %
REVENUES
Total revenues increased $66.8 million, or 56%, to $185.7 million during the six months ended December 31, 2016 as compared to the same period in fiscal 2016. The increase in total revenues is primarily attributed to $50.3 million of revenue from the Carve-Out Business and $4.0 million from the newly acquired CES. The increase of $12.5 million organic revenue is primarily attributed to increases in the Aegis, LRDR, and F-35 programs, partially offset by lower revenues from the Patriot and SEWIP programs. International revenues, which consist of foreign military sales through prime defense contractor customers and direct sales to non-U.S. based customers, were $29.1 million during the six months ended December 31, 2016, compared to $21.1 million in the same period in the prior fiscal year. International revenues represented 16% and 18% of total revenues during the six months ended December 31, 2016 and 2015, respectively.
GROSS MARGIN
Gross margin was 46.8% for the six months ended December 31, 2016, a decrease of 200 basis points from the 48.8% gross margin during the same period in fiscal 2016. The lower gross margin between years was driven by the amortization of $2.9 million in inventory step-up during the six months ended December 31, 2016 related to the acquisitions of the Carve-Out Business and CES, and changes in product mix.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased $12.2 million, or 49%, to $36.9 million during the six months ended December 31, 2016, compared to $24.7 million in the same period in fiscal 2016. The increase was primarily due to higher compensation expense due to increased headcount from the acquisition of the Carve-Out Business and the acquisition of CES, coupled with $0.7 million in non-cash rent expense associated with our new corporate headquarters in Andover, Massachusetts and higher depreciation expense of $0.5 million due to the acquired businesses during the six months ended December 31, 2016. Selling, general and administrative expenses decreased as a percentage of revenues to 19.9% during the six months ended

21



December 31, 2016 from 20.8% during the same period in fiscal 2016. The decrease was due to higher revenues in the first six months of fiscal 2017, as compared to the same period in fiscal 2016.
RESEARCH AND DEVELOPMENT
Research and development expenses increased $8.3 million, or 47% to $26.0 million during the six months ended December 31, 2016, compared to $17.7 million during the same period in fiscal 2016. The increase was primarily due to increased headcount resulting from the acquisition of the Carve-Out Business and the acquisition of CES driving higher compensation related costs, higher depreciation and increased prototype expenditures.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges were $0.4 million for the six months ended December 31, 2016, as compared to $0.6 million during the same period in fiscal 2016. Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities.
ACQUISITION COSTS AND OTHER RELATED EXPENSES
We incurred $1.4 million of acquisition costs and other related expenses during the six months ended December 31, 2016, compared to $2.0 million during the same period in fiscal 2016. We expect to incur acquisition costs and other related expenses periodically in the future as we continue to seek acquisition opportunities to expand our capabilities within the sensor processing chain.
INTEREST EXPENSE
We incurred $3.7 million of interest expense during the six months ended December 31, 2016 compared to less than $0.1 million in the same period in fiscal 2016. The increase was driven by $2.8 million cash interest expense related to our Term Loan and $0.9 million of non-cash interest expense related to the amortization of debt issuance costs on our Term Loan, which was entered into during the fourth quarter of fiscal 2016.
OTHER INCOME, NET
Other income, net was $0.5 million during the six months ended December 31, 2016, compared to $0.2 million during the same period in fiscal 2016. Both periods include $0.6 million related to the amortization of the gain on the sale leaseback of our corporate headquarters. The gain was partially offset by $0.2 million and $0.4 million in bank fees during the six months ended December 31, 2016 and 2015, respectively.
INCOME TAXES
We recorded an income tax provision of $0.5 million during the six months ended December 31, 2016 as compared to $1.8 million for the same period in fiscal 2016. During the six months ended December 31, 2016, and 2015, we recognized a discrete tax benefit of $2.8 million and $1.1 million, respectively, related to excess tax benefits on stock-based compensation. Our effective tax rates for the six months ended December 31, 2016 and 2015 differed from the federal statutory tax rate of 35% primarily due to federal research and development tax credits, domestic manufacturing deduction, excess benefits related to stock compensation, and state taxes.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity comes from existing cash and cash generated from operations and our revolving credit facility. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments with our contract manufacturers, and interest and principal payments under our Term Loan. Additionally, we currently expect approximately $15.0 million to $16.0 million of capital expenditures related to the build-out of our new corporate headquarters, and integration activities associated with the Carve-Out Business in the third quarter of fiscal 2017.
Based on our current plans and business conditions, we believe that existing cash and cash equivalents, available revolving credit facility, cash generated from operations, and financing capabilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.
Term Loan and Revolving Credit Facilities
On May 2, 2016, we entered into a $200.0 million senior secured term loan A and $100.0 million revolving credit facility (“Revolver”) with a syndicate of commercial banks, with Bank of America, N.A. acting as the administrative agent (collectively, the “Credit Agreement”). Pursuant to the Revolver we can, subject to compliance with the applicable financial covenants, borrow up to $100.0 million for working capital, acquisitions, and general corporate purposes of ours and our subsidiaries. As of December 31, 2016, there was $100.0 million of borrowing capacity available under the Revolver. As of December 31, 2016, there

22



were no borrowings outstanding on the Revolver; however, there were outstanding letters of credit of $5.6 million. The Company was in compliance with all covenants and conditions under the Credit Agreement.
Shelf Registration Statement
On August 15, 2014, we filed a shelf registration statement on Form S-3 with the SEC. The shelf registration statement, which has been declared effective by the SEC, registered up to $500.0 million of debt securities, preferred stock, common stock, warrants and units. We intend to use the proceeds from a financing using the shelf registration statement for general corporate purposes, which may include the following:
the acquisition of other companies or businesses;
the repayment and refinancing of debt;
capital expenditures;
working capital; and
other purposes as described in the prospectus supplement.
We have approximately $190.0 million of availability remaining under the shelf registration statement.
Equity Offering
On January 26, 2017, we entered into an underwriting agreement. Pursuant to the terms and conditions of the underwriting agreement, we agreed to sell 6.0 million shares of its common stock, par value $0.01 per share, at a price to the public of $33.00 per share. Pursuant to the underwriting agreement, we granted the underwriters an option to purchase up to an additional 0.9 million shares of its common stock within 30 days after the date of the underwriting agreement to cover the overallotment.
The offering was made pursuant to a shelf registration statement previously filed with the SEC on August 15, 2014. On February 1, 2017, we closed the offering, including the full over-allotment allocation, selling an aggregate of 6.9 million shares of common stock for total proceeds of $216.3 million before expenses, but after underwriting fees of $11.4 million. We intend to use the net proceeds for general corporate purposes, including but not limited to: the acquisition of other companies or businesses, the refinancing or repayment of debt, working capital, share repurchases and capital expenditures.
CASH FLOWS
 
 
As Of and For the Six
Month Period Ended
December 31,
(In thousands)
 
2016
 
2015
Net cash provided by operating activities
 
$
24,521

 
$
18,837

Net cash used in investing activities
 
$
(52,628
)
 
$
(13,105
)
Net cash used in financing activities
 
$
(7,327
)
 
$
(1,827
)
Net (decrease) increase in cash and cash equivalents
 
$
(35,506
)
 
$
3,968

Cash and cash equivalents at end of period
 
$
46,185

 
$
81,554

Our cash and cash equivalents decreased by $35.5 million from June 30, 2016 to December 31, 2016, primarily as a result of $38.8 million used in the acquisition of CES, $13.8 million in purchases of property and equipment, and $7.6 million for the retirement of common stock, partially offset by $24.5 million in cash generated from operating activities. The increase in purchases of property and equipment in fiscal 2017 is due to the ongoing needs in our existing business including the build-out of our new corporate headquarters and integration activities associated with the Carve-Out Business.
Operating Activities
During the six months ended December 31, 2016, we generated $24.5 million in cash from operating activities, an increase of $5.7 million when compared to the same period in fiscal 2016. During the six months ended December 31, 2016, we incurred $8.6 million higher depreciation and amortization expense, and we generated $7.4 million higher collections from accounts receivables as compared to the same period in fiscal 2016. The increases were partially offset by $7.8 million of cash used for accounts payable and accrued expenses, and $3.3 million decrease in deferred revenues and customer advances as compared to the same period in the prior year. Our ability to generate cash from operations in future periods will depend in large part on profitability, the rate and timing of collections of accounts receivable, our inventory turns and our ability to manage other areas of working capital.

23



Investing Activities
During the six months ended December 31, 2016, we used $52.6 million in investing activities compared to $13.1 million during the same period in fiscal 2016. The increase was primarily driven by $38.8 million in cash used to acquire CES as compared to $9.8 million in cash used to acquire LIT in the same period of fiscal 2016. Additionally, we incurred $10.6 million higher purchases of property and equipment in fiscal 2017 due to the ongoing needs in our existing business including the build-out of our new corporate headquarters and integration activities associated with the Carve-Out Business.
Financing Activities
During the six months ended December 31, 2016, we used $7.3 million in financing activities compared to $1.8 million during the same period in fiscal 2016. The $5.5 million increase in cash used in financing activities was primarily due to an additional $3.4 million for the retirement of common stock and a debt principal payment of $2.5 million during the six months ended December 31, 2016.
COMMITMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENCIES
The following is a schedule of our commitments and contractual obligations outstanding at December 31, 2016:
(In thousands)
 
Total
 
Less Than
1 Year
 
1-3
Years
 
3-5
Years
 
More Than
5 Years
Purchase obligations
 
$
41,603

 
$
41,603

 
$

 
$

 
$

Operating leases
 
44,663

 
6,689

 
10,560

 
8,344

 
19,070

Debt principal payment obligations (1)
 
197,500

 
10,000

 
32,500

 
155,000

 

 
 
$
283,766

 
$
58,292

 
$
43,060

 
$
163,344

 
$
19,070

(1) Interest payments are due quarterly on the outstanding term loan. Future interest payments are not included in the schedule of commitments and contractual obligations due to the variable nature of the interest rate.
Purchase obligations represent open non-cancelable purchase commitments for certain inventory components and services used in normal operations. The purchase commitments covered by these agreements are for less than one year and aggregated approximately $41.6 million at December 31, 2016.
We have a liability at December 31, 2016 of $1.6 million for uncertain tax positions that have been taken or are expected to be taken in various income tax returns. It is reasonably possible that within the next 12 months this liability, exclusive of interest, may decrease by up to $0.8 million upon the conclusion of the Internal Revenue Service audit of fiscal year 2013. We do not know the ultimate resolution on these uncertain tax positions and as such, do not know the ultimate timing of payments related to this liability. Accordingly, these amounts are not included in the above table.
Our standard product sales and license agreements entered into in the ordinary course of business typically contain an indemnification provision pursuant to which we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred in connection with certain intellectual property infringement claims by any third party with respect to our products. Such provisions generally survive termination or expiration of the agreements. The potential amount of future payments we could be required to make under these indemnification provisions is, in some instances, unlimited.
As part of our strategy for growth, we continue to explore acquisitions or strategic alliances. The associated acquisition costs incurred in the form of professional fees and services may be material to the future periods in which they occur, regardless of whether the acquisition is ultimately completed.
We may elect from time to time to purchase and subsequently retire shares of common stock in order to settle individual employees’ tax liability associated with vesting of a restricted stock award or exercise of stock options. These transactions would be treated as a use of cash in financing activities in our statement of cash flows.
OFF-BALANCE SHEET ARRANGEMENTS
Other than our lease commitments incurred in the normal course of business and certain indemnification provisions, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.

24



NON-GAAP FINANCIAL MEASURES
In our periodic communications, we discuss certain important measures that are not calculated according to U.S. generally accepted accounting principles (“GAAP”), adjusted EBITDA, adjusted income, adjusted earnings per share ("adjusted EPS") and free cash flow.
Adjusted EBITDA is defined as net income before interest income and expense, income taxes, depreciation, amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, and stock-based compensation expense. We use adjusted EBITDA as an important indicator of the operating performance of our business. We use adjusted EBITDA in internal forecasts and models when establishing internal operating budgets, supplementing the financial results and forecasts reported to our board of directors, determining a component of bonus and equity compensation for executive officers based on operating performance and evaluating short-term and long-term operating trends in our operations. We believe the adjusted EBITDA financial measure assists in providing a more complete understanding of our underlying operational measures to manage our business, to evaluate our performance compared to prior periods and the marketplace, and to establish operational goals. We believe that these non-GAAP financial adjustments are useful to investors because they allow investors to evaluate the effectiveness of the methodology and information used by management in our financial and operational decision-making.
Adjusted EBITDA is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenses similar to the adjusted EBITDA financial adjustments described above, and investors should not infer from our presentation of this non-GAAP financial measure that these costs are unusual, infrequent or non-recurring.
The following table reconciles our net income, the most directly comparable GAAP financial measure, to our adjusted EBITDA:
 
 
Three Months Ended 
 December 31,
 
Six Months Ended 
 December 31,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Net income
 
$
5,204

 
$
5,040

 
$
9,023

 
$
7,896

Interest expense (income), net
 
1,888

 
(21
)
 
3,670

 
(43
)
Income taxes
 
1,779

 
1,433

 
520

 
1,801

Depreciation
 
2,966

 
1,620

 
5,684

 
3,208

Amortization of intangible assets
 
4,888

 
1,638

 
9,490

 
3,351

Restructuring and other charges (1)
 
69

 
221

 
366

 
559

Impairment of long-lived assets
 

 
231

 

 
231

Acquisition and financing costs
 
1,114

 
25

 
1,667

 
2,323

Fair value adjustments from purchase accounting (2)
 
870

 

 
2,947

 

Litigation and settlement expense (income), net
 
100

 

 
100

 

Stock-based compensation expense
 
4,093

 
2,392

 
7,725

 
5,094

Adjusted EBITDA
 
$
22,971

 
$
12,579

 
$
41,192

 
$
24,420

(1) Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. The Company believes these items are non-routine and may not be indicative of ongoing operating results.
(2) Fair value adjustments from purchase accounting for the three and six months ended December 31, 2016 relates to Carve-Out Business and CES inventory step up amortization.
Adjusted income and adjusted EPS exclude the impact of certain items and, therefore, have not been calculated in accordance with GAAP. We believe that exclusion of these items assists in providing a more complete understanding of our underlying results and trends and allows for comparability with our peer company index and industry. We use these measures along with the corresponding GAAP financial measures to manage our business and to evaluate our performance compared to prior periods and the marketplace. We define adjusted income as income before amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, and stock-based compensation expense. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision. Adjusted EPS expresses adjusted income on a per share basis using weighted average diluted shares outstanding.

25



Adjusted income and adjusted EPS are non-GAAP financial measures and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. These non-GAAP financial measures may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenses similar to the adjusted income and adjusted EPS financial adjustments described above, and investors should not infer from our presentation of these non-GAAP financial measures that these costs are unusual, infrequent or non-recurring.
The following table reconciles net income and diluted earnings per share, the most directly comparable GAAP measures, to adjusted income and adjusted EPS:
 

Three Months Ended
December 31,
(In thousands, except per share data)
 
2016
 
2015
Net income and diluted earnings per share
 
$
5,204

 
$
0.13

 
$
5,040

 
$
0.15

   Amortization of intangible assets
 
4,888

 
 
 
1,638

 
 
   Restructuring and other charges (1)
 
69

 
 
 
221

 
 
   Impairment of long-lived assets
 

 
 
 
231

 
 
   Acquisition and financing costs
 
1,114

 
 
 
25

 
 
   Fair value adjustments from purchase accounting (2)
 
870

 
 
 

 
 
   Litigation and settlement expenses (income), net
 
100

 
 
 

 
 
   Stock-based compensation expense
 
4,093

 
 
 
2,392

 
 
   Impact to income taxes (3)
 
(4,441
)
 
 
 
(1,722
)
 
 
Adjusted income and adjusted earnings per share
 
$
11,897

 
$
0.30

 
$
7,825

 
$
0.23

 
 
 
 
 
 
 
 
 
Diluted weighted-average shares outstanding
 
 
 
39,985

 
 
 
33,831

(1) Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. The Company believes these items are non-routine and may not be indicative of ongoing operating results.
(2) Fair value adjustments from purchase accounting for the three months ended December 31, 2016 relates to Carve-Out Business and CES inventory step up amortization.
(3) Impact to income taxes is calculated by recasting income before income taxes to include the add-backs involved in determining adjusted income and recalculating the income tax provision using this adjusted income from operations before income taxes. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision.
 
 
Six Months Ended
December 31,
(In thousands, except per share data)
 
2016
 
2015
Net income and diluted earnings per share
 
$
9,023

 
$
0.23

 
$
7,896

 
$
0.23

   Amortization of intangible assets
 
9,490

 
 
 
3,351

 
 
   Restructuring and other charges (1)
 
366

 
 
 
559

 
 
   Impairment of long-lived assets
 

 
 
 
231

 
 
   Acquisition and financing costs
 
1,667

 
 
 
2,323

 
 
   Fair value adjustments from purchase accounting (2)
 
2,947

 
 
 

 
 
   Litigation and settlement expenses (income), net
 
100

 
 
 

 
 
   Stock-based compensation expense
 
7,725

 
 
 
5,094

 
 
   Impact to income taxes (3)
 
(10,526
)
 
 
 
(5,188
)
 
 
Adjusted income and adjusted earnings per share
 
$
20,792

 
$
0.52

 
$
14,266

 
$
0.42

 
 
 
 
 
 
 
 
 
Diluted weighted-average shares outstanding
 
 
 
39,920

 
 
 
33,819

(1) Restructuring and other charges are typically related to acquisitions and organizational redesign programs initiated as part of discrete post-acquisition integration activities. The Company believes these items are non-routine and may not be indicative of ongoing operating results.
(2) Fair value adjustments from purchase accounting for the six months ended December 31, 2016 relates to Carve-Out Business and CES inventory step up amortization.
(3) Impact to income taxes is calculated by recasting income before income taxes to include the add-backs involved in determining adjusted income and recalculating the income tax provision using this adjusted income from operations before income taxes. The impact to income taxes includes the impact to the effective tax rate, current tax provision and deferred tax provision.

26



Free cash flow, a non-GAAP measure for reporting cash flow, is defined as cash provided by operating activities less capital expenditures for property and equipment, which includes capitalized software development costs. We believe free cash flow provides investors with an important perspective on cash available for investments and acquisitions after making capital investments required to support ongoing business operations and long-term value creation. We believe that trends in our free cash flow are valuable indicators of our operating performance and liquidity.
Free cash flow is a non-GAAP financial measure and should not be considered in isolation or as a substitute for financial information provided in accordance with GAAP. This non-GAAP financial measure may not be computed in the same manner as similarly titled measures used by other companies. We expect to continue to incur expenditures similar to the free cash flow adjustment described above, and investors should not infer from our presentation of this non-GAAP financial measure that these expenditures reflect all of our obligations which require cash.
The following table reconciles cash provided by operating activities, the most directly comparable GAAP financial measure, to free cash flow:
 
 
Three Months Ended 
 December 31,
 
Six Months Ended 
 December 31,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Cash provided by operating activities
 
$
14,238

 
$
12,255

 
$
24,521

 
$
18,837

Purchase of property and equipment
 
(7,703
)
 
(1,289
)
 
(13,753
)
 
(3,156
)
Free cash flow
 
$
6,535

 
$
10,966

 
$
10,768

 
$
15,681

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on July 1, 2018, and we do not plan to early adopt this ASU. The standard permits the use of either the retrospective or cumulative effect transition method. We are still evaluating the effect that ASU 2014-09 will have on our past and future revenue recognition and related disclosure.
In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, an amendment of the FASB Accounting Standards Codification. The ASU has added additional disclosure requirements to the codification. It requires management to assess, at each interim and annual reporting period, whether substantial doubt exists about the company’s ability to continue as a going concern. Substantial doubt exists if it is probable (the “probable” threshold under U.S. GAAP has generally been interpreted to be between 75 and 80 percent) that the company will be unable to meet its obligations as they become due within one year after the date the financial statements are issued or available to be issued (assessment date). The ASU is effective for annual reporting periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. We do not expect a going concern uncertainty in the foreseeable future, and therefore this guidance is not expected to have a material impact to our consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, an amendment of the FASB Accounting Standards Codification. This ASU changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value for entities that do not measure inventory using the last-in, first-out or retail inventory method. The ASU also eliminates the requirement for these entities to consider replacement cost or net realizable value less an approximately normal profit margin when measuring inventory. The ASU is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those years. The ASU requires prospective adoption and permits early adoption. We are evaluating the effect that ASU 2015-11 will have on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), an amendment of the FASB Accounting Standards Codification. This ASU requires lessees to recognize a right-of-use asset and lease liability for most lease arrangements. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2018. The standard mandates a modified retrospective transition method for all entities and early adoption is permitted. We are evaluating the effect that ASU 2016-02 will have on our consolidated financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, an amendment of the FASB Accounting Standards Codification. This ASU will reduce diversity in practice for classifying cash payments and receipts in the statement of cash flows for a number of common transactions. It will also clarify when identifiable cash flows should be separated versus classified based on their predominant source or use. This ASU is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be

27



reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. We are evaluating the effect that ASU 2016-15 will have on our consolidated financial statements and related disclosures.
In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, an amendment of the FASB Accounting Standards Codification. This ASU requires the seller and buyer to recognize at the transaction date the current and deferred income tax consequences of intercompany asset transfers (except transfers of inventory). Under current U.S. GAAP, the seller and buyer defer the consolidated tax consequences of an intercompany asset transfer from the period of the transfer to a future period when the asset is transferred out of the consolidated group, or otherwise affects consolidated earnings. This standard will cause volatility in companies’ effective tax rates, particularly for those that transfer intangible assets to foreign subsidiaries. For public entities, the new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2017. An entity may early adopt the standard but only at the beginning of an annual period for which it has not issued or made available for issuance financial statements (interim or annual). We are evaluating the effect that ASU 2016-16 will have on our consolidated financial statements and related disclosures.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Effective July 1, 2016, we adopted FASB ASU No. 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items, an amendment of the FASB Accounting Standards Codification. This ASU eliminates the separate presentation of extraordinary items, net of tax and the related earnings per share, but does not affect the requirement to disclose material items that are unusual in nature or infrequently occurring. The ASU aligns U.S. GAAP more closely with International Financial Reporting Standards. We will continue to evaluate whether items are unusual in nature or infrequent in their occurrence for disclosure purposes and when estimating the annual effective tax rate for interim reporting purposes. Such adoption did not have any impact to our consolidated financial statements.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were no material changes in our exposure to market risk from June 30, 2016 to December 31, 2016.
ITEM 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
We conducted an evaluation under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), regarding the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2016. We continue to review our disclosure controls and procedures and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our Company’s business. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
(b) Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13c-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, management is in the process of integrating the recently acquired Carve-Out Business and CES into our overall internal control over financial reporting environment.

29



PART II. OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
We are subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business. Although legal proceedings are inherently unpredictable, we believe that we have valid defenses with respect to those matters currently pending against us and intend to defend our self vigorously. The outcome of these matters, individually and in the aggregate, is not expected to have a material impact on our cash flows, results of operations, or financial position.
ITEM 1A.
RISK FACTORS
You should carefully review and consider the information regarding certain factors that could materially affect our business, financial condition or future results set forth under Item 1A (Risk Factors) in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016. There have been no material changes from the factors disclosed in our 2016 Annual Report on Form 10-K filed on August 16, 2016, although we may disclose changes to such factors or disclose additional factors from time to time in our future filings with the Securities and Exchange Commission.
ITEM 6.
EXHIBITS
The following Exhibits are filed or furnished, as applicable, herewith:
31.1
  
Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2
  
Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1+
  
Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101
  
The following materials from the Company’s Quarterly Report on the Form 10-Q for the quarter ended December 31, 2016 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Cash Flows; and (iv) notes to the Consolidated Financial Statements
 +
Furnished herewith. This certificate shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, nor shall it be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

30



MERCURY SYSTEMS, INC.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Chelmsford, Massachusetts, on February 9, 2017.
MERCURY SYSTEMS, INC.
 
 
By:
 
/S/    GERALD M. HAINES II
 
 
Gerald M. Haines II
 
 
Executive Vice President,
 
 
Chief Financial Officer, and Treasurer

31